A LOAN MARKET ASSOCIATION UPDATE INSOLVENCY IN THE LOAN MARKET. Loan Market Association. 10 Upper Bank Street, London E14 5JJ

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1 A LOAN MARKET ASSOCIATION UPDATE INSOLVENCY IN THE LOAN MARKET Loan Market Association 10 Upper Bank Street, London E14 5JJ Loan Market Association 2013 Published by the Loan Market Association 10 Upper Bank Street, London E14 5JJ Telephone: +44 (0) Fax: +44 (0) Website: All rights reserved. No part of this publication may be reproduced, stored in any retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the copyright holder, for which application should be addressed in the first instance to the publishers. No liability shall attach to the authors, the copyright holder or the publishers for loss or damage of any nature suffered as a result of the reproduction of any of the contents of this publication. The views and opinions expressed in this publication are the views of the authors. The Loan Market Association and the authors have made every effort to ensure the complete accuracy of the text but none of the Loan Market Association, the authors or the publishers can accept any legal responsibility or liability for any error or omission in its contents. This "Insolvency in the Loan Market" update is not intended to be completely comprehensive. Rather, it seeks to set out recent and proposed legislation in major EU jurisdictions, and to assess the possible impact on the syndicated loan market. Most importantly, this publication is not designed to provide legal or other advice on any matter whatsoever. The Loan Market Association The Loan Market Association (LMA) is the trade body for the EMEA syndicated loan market and was founded in December 1996 by banks operating in that market. Its aim is to encourage liquidity in both the primary and secondary loan markets by promoting efficiency and transparency, as well as by developing standards of documentation and codes of market practice, which are widely used and adopted. Membership of the LMA currently stands at over 500 and consists of banks, non bank lenders, law firms, rating agencies and service providers. The LMA has gained substantial recognition in the market and has expanded its activities to include all aspects of the primary and secondary syndicated loan markets. It sees its overall mission as acting as the authoritative voice of the EMEA loan market vis à vis lenders, borrowers, regulators and other interested parties.

2 CONTENTS Page Number INTRODUCTION AND ACKNOWLEDGEMENTS 3 1. EUROPEAN UNION 4 2. FRANCE 6 3. GERMANY 8 4. ITALY SPAIN UNITED KINGDOM 21 CONCLUSION 24 2

3 INTRODUCTION From the fallout of Dubai World to the collapse of Lehman Brothers, the financial crisis has seen an unprecedented volume of new legislation which has had, and will continue to have, a significant impact on financial institutions globally. There are numerous issues concerning financial regulation which the current financial turmoil has highlighted, from bank insolvency regimes to commercial bank liquidity risk and crisis management. Governing authorities have responded to these concerns both at a national and international level, causing fears in the market that institutions may become exposed to conflicting regimes. It is imperative for the future success of these initiatives, and the stability of the financial sector, that authorities work together and take an integrated and globally consistent approach to ensure alignment with other proposals. Numerous big ideas have been floated on how the banking industry should be restructured in the aftermath of the crisis, from those calling for the imposition of a global liquidity standard (e.g. Basel III) to those identifying possible models of structural separation (e.g. the Volker, Vickers and Liikanen reports). However, this paper does not focus on those initiatives which seek to safeguard against future financial crises, but instead seeks to address those initiatives which look to amend the underlying insolvency regimes across Western Europe and strengthen the rescue culture of the jurisdictions therein. The aim of this paper is threefold: (1) to inform loan market participants of the key legislative changes which have been effected in insolvency markets across Western Europe; (2) to consider measures currently under review within the European Union, which are likely to shape national legislation going forward; and (3) to assess the cumulative effect of these measures and what they, as a package, could mean for the syndicated loan market henceforth. ACKNOWLEDGEMENTS The LMA would like to thank Clifford Chance LLP, who assisted with the production of this paper. 3

4 Section 1 EUROPEAN UNION The European sovereign debt crisis, the call for emergency bailouts, the downgrading of government debt and the possible break up of the Eurozone have forced legislators to review national and pan European policies, with a view to promoting stability within European markets. Before considering the individual jurisdictions, it is therefore important to consider the recent reforms and recovery proposals put forward at a pan European level, as these are likely to influence the future direction of national legislation. This Section will provide a high level review of the European Regulation on Insolvency Proceedings 1 (the "Insolvency Regulation") and the issues which the recent European Commission's proposal of reform (the "Proposal") seeks to address. This Section will not provide a detailed review of the Proposal, which is likely to undergo further consultation and review going forward. A. THE EUROPEAN REGULATION ON INSOLVENCY PROCEEDINGS The Insolvency Regulation came into effect on 31 May 2002, primarily adopted to improve the efficiency and effectiveness of cross border insolvency proceedings and prevent the use of "forum shopping", which came about as a result of disparities between national insolvency laws. It achieved this via the implementation of rules determining (1) the proper jurisdiction for a debtor's insolvency proceeding; (2) the applicable law to be used in any such proceedings; and (3) the mandatory recognition of proceedings in other EU member states. In December 2012, ten years following its introduction, the European Commission announced a proposal to update the Insolvency Regulation. This introduced a shift in emphasis to the promotion of pre insolvency and rescue proceedings, in recognition of the pre insolvency techniques developed by national jurisdictions in light of the global financial crisis (explored in more detail in later Sections). From the perspective of the loan market, the good news is that secured creditors who under the Insolvency Regulation are able, generally speaking, to rely upon their existing rights and security without interference from an insolvency process in another jurisdiction, will continue to do so under the amendments put forward in the Proposal. Amongst other things, the Proposal seeks to address the following problems identified in relation to the Insolvency Regulation: I. SCOPE The current scope of the Insolvency Regulation does not extend to pre insolvency and hybrid proceedings. For many member states these types of rescue processes are becoming more prevalent and are considered to increase the chances of a successful restructuring of businesses. It is therefore seen as a positive step in cross border restructurings that the Proposal seeks to extend the benefit of automatic recognition under the Insolvency Regulation to such processes. 1 Council Regulation 1346/

5 II. JURISDICTION FOR OPENING PROCEEDINGS Due to discrepancies in the interpretation of the Insolvency Regulation, there has been criticism that the Insolvency Regulation fails to prevent forum shopping by companies and natural persons. Uncertainty in the application of the Insolvency Regulation has led to a substantial volume of case law having been generated since its introduction, with disagreements as to where the centre of main interest ("COMI") is located being ultimately resolved by the European Court of Justice 2. The Proposal therefore aims to clarify the circumstances for satisfying the COMI requirement when commencing insolvency proceedings, by stating that it is possible to rebut the "registered office presumption" if a company's central administration, including the company's centre of management and supervision, is located in another member state. III. SECONDARY PROCEEDINGS The Insolvency Regulation provides for the possibility of having two concurrent insolvency proceedings in respect of the same debtor, which can give rise to significant cost and complexity, thereby hampering the efficiency of the main proceedings. The Proposal allows liquidators in the main proceedings to request that secondary proceedings are not opened, or are postponed, unless they are considered necessary to protect the interests of local creditors. In the event that secondary proceedings are opened, these would no longer be limited to a winding up of the business, thereby complementing any restructuring that may be taking place within the main proceedings. There is also an obligation on the liquidators of both the main and secondary proceedings to cooperate and communicate with each other. IV. GROUP COMPANIES Despite a large number of cross border insolvencies involving groups of companies, the Insolvency Regulation is silent on how to deal with the insolvency of a multi national enterprise group. To address this, a new chapter has been introduced under the Proposal to deal with the insolvency of members of a group of companies whilst maintaining the entity by entity approach which underlies the current Insolvency Regulation. This new chapter specifically promotes cooperation and communication between officeholders and courts in different member states and imposes a duty on officeholders to explore and encourage restructuring on a group wide basis where this is possible. The Proposal is now to be considered by the European Parliament and also the Council of the EU before it is adopted. 2 See Interedil Srl (in liquidation) v Fallimento Interedil Srl and another [2011] EUECJ C

6 Section 2 FRANCE Historically, France has been perceived as a pro debtor jurisdiction. However, the 2009 wave of restructurings of leveraged transactions, including the Monier Group, the SGD Group (formerly Saint Gobain Desjonquères) and the CPI Group, appears to have suggested a shift in favour of creditors. Potentially the most interesting of the recent restructurings was that of Autodis, a French car parts company, where the debtor, its equity sponsor and its creditors signed the first pre packaged restructuring agreement ever in France. This arguably paved the way for the Technicolor (formerly known as Thomson) restructuring, being the second largest French restructuring in history after Eurotunnel, and the successive amendments the French legislative made to insolvency law, explored in greater detail below. A. SAUVEGARDE FINANCIÈRE ACCÉLÉRÉE On 11 October 2010, the National Assembly adopted the Banking and Financial Regulation Act 3 (loi de regulation bancaire et financière), codified in Articles L to L of the French Commercial Code. This was primarily aimed at increasing the security of the financial system and created the accelerated financial safeguard procedure (sauvegarde financière accélérée, the "Procedure") 4, inspired by the US Chapter 11. The objective of the Procedure is to restructure financial debt in a very short time frame (i.e. a maximum of two months) 5 and enable a debtor to implement a restructuring plan without affecting the position of its trade creditors. The Procedure is only applicable to financial creditors and provides a means to cramdown any dissentient minority who otherwise may seek to prevent a restructuring. It requires the approval of two thirds of its financial creditors (mainly credit institutions and bondholders). The proceedings do not affect the rights of creditors that are not financial creditors (e.g. trade creditors, tax or social security administrations) who will continue to be paid in the ordinary course of business, in order to preserve the company's operational activities. The Procedure may only be initiated by an applicant where: the test for the "classical safeguard" procedure (procedure de sauvegarde) is met, i.e. the company must be solvent, but facing legal, economic or financial difficulties, actual or anticipated, which it will not be able to overcome 6 ; the company has total net assets 7 exceeding 25 million 8. This threshold is reduced to 10 3 Law n o dated 22 October See articles 57 and 58 of the Banking and Financial Regulation Act. 5 Article L of the French Commercial Code. 6 In the Coeur Défense case, the Cour de Cassation held that no restriction shall apply to the concept of "difficulty" justifying the opening of a safeguard. In this case, the court ruled that the necessity for the debtor to renegotiate (in the case of an event of default) the terms and conditions of a loan may constitute a difficulty allowing such debtor to petition for safeguard proceedings. 7 i.e. the total sum of the net value of its assets in accordance with article R of the French Commercial Code. 8 Initially, the Procedure was only available for companies which had more than 150 employees or a minimum annual turnover of 20 million, conditions which were not met by holding companies. This restriction was subsequently relaxed by Decree n o dated 20 6

7 million where the debtor is a company controlling 9 another which has (1) more than 150 employees; or (2) revenues for the previous financial year exceeding 20 million; or (3) total net assets exceeding 25 million. Holding companies which hold sufficient financial debt will therefore be eligible; the company is already subject to conciliation proceedings (procedure de conciliation), direct access to the expedited safeguard is strictly prohibited, and a restructuring plan ensuring the continuation of the business as a going concern has been prepared 10 ; and the company can demonstrate that its proposed restructuring plan is capable of receiving enough support to be likely to be adopted by two thirds of its financial creditors (both twothirds of the credit institutions and two thirds of the bondholders) within one month (extendable by one month) from the opening of the Procedure. IMPACT ON THE LOAN MARKET The introduction of the fast track insolvency reforms is likely to promote France as a jurisdiction where effective business rescue can take place. This may improve the level of funding available to French institutions, and the fact that the new accelerated safeguard procedure benefits from Europe wide recognition under the Insolvency Regulation may give France a competitive edge in the international restructuring arena. The Double LuxCo structure In reaction to situations where borrowers adopted a very aggressive approach and used safeguard proceedings in a hostile manner towards the lenders (in particular in the famous Coeur Défense case), a new structure (the so called "Double LuxCo" structure) is now used in French leveraged buyout financings in order to circumvent the effects of such hostile safeguard proceedings. In brief, this structure consists in placing two Luxembourg holding companies on top of the French entities, each of them granting a share pledge over the shares of its subsidiary. This structure allows the lenders to enforce their share pledges and take control of the group in the event that any or all of the entities place themselves into insolvency proceedings either in France or in Luxembourg. September This decree implements Law n o dated 22 March 2012 (loi relative à la simplification du droit et à l'allégement des démarches administratives) which replaced the previous eligibility criteria for the accelerated financial safeguard procedure (article D of the French Commercial Code). 9 "Control" defined by reference to article L I 1 o of the French Commercial Code. 10 The restructuring plan must take into consideration subordination agreements concluded before the opening of insolvency proceedings (article L of the French Commercial Code). 7

8 Section 3 GERMANY Over the course of the recent global financial crisis, the German economy has demonstrated a strength and resilience which continues to underpin much of Western Europe. However, prior to the implementation of recent reforms, the German insolvency regime had not fared so well. Creditors, distressed companies and other stakeholders held the view that restructurings under the German insolvency regime were difficult to complete, time consuming and unpredictable in outcome, the process being primarily court and administrator led, with limited influence from the creditors or debtor. As a result, a significant number of major restructurings concerning distressed German companies took place in other jurisdictions, e.g. the restructurings of Schefenacker 11, Tele Columbus 12, PrimaCom 13 and Rodenstock 14 were implemented through English schemes of arrangement. Evidence of "forum shopping" put the spotlight on German insolvency law, where it was recognised that the restructuring tools on offer were widely considered to be inadequate to sufficiently satisfy the interests of both creditors and debtors. This led to a substantial reform of German insolvency law, aimed at facilitating the implementation of restructuring solutions, such as debt to equity swaps and the cramming down of junior creditor claims, explored in greater detail below. A. ACT FOR THE FURTHER FACILITATION OF THE RESTRUCTURING OF CORPORATIONS On 27 October 2011, the German Bundestag passed the Act for the Further Facilitation of the Restructuring of Corporations (Gesetz zur Erleichterung der Sanierung von Unternehmen ("ESUG")), which came into effect on 1 March ESUG is intended to strengthen creditors' rights and to expand the scope of insolvency plan proceedings via the implementation of the following provisions: I. PRELIMINARY CREDITORS' COMMITTEE AND SELECTION OF INSOLVENCY ADMINISTRATOR Upon receipt of a petition to commence insolvency proceedings, ESUG requires the court to appoint a preliminary creditors' committee provided two of the following three criteria have been fulfilled in the last business year of the debtor company: 1. total balance sheet assets of not less than 4.84 million; 2. turnover of not less than 9.68 million in the last 12 months prior to the end of the last business year; and 3. not fewer than 50 employees on a yearly average. In order to aid the court in the appointment of a preliminary creditors' committee, ESUG requires the debtor to provide the court with a list of its creditors when submitting its petition to commence 11 (2007) December 2010, unreported. 13 [2012] EWHC 164 (Ch). 14 [2011] EWHC 1104 (Ch). 8

9 insolvency proceedings. Once appointed, the preliminary creditors' committee has the right to be directly involved in the selection of an insolvency administrator, a determination previously reserved by the court. Creditors should therefore have a stronger influence on the choice of an insolvency administrator and will be able to use this influence to ensure that a business orientated and going concernorientated administrator is appointed. This should improve the reliability and predictability of any insolvency proceedings. In certain circumstances, the court may appoint an administrator ahead of the formation of the preliminary creditors' committee. However, once formed the preliminary creditors' committee can, at its first meeting and by unanimous decision, elect another person be appointed administrator. II. INSOLVENCY PLAN AND DEBT TO EQUITY SWAP ESUG provides for a more classical US Chapter 11 style debt to equity swap to take place in an insolvency proceeding. This allows for the cram down of the equity holders of a company and a conversion of creditor claims to shares in the company in an attempt to facilitate the maintenance of the legal entity behind the business. Before ESUG, such debt to equity swaps were not possible in the absence of a consenting shareholders' resolution. This is no longer the case. Debt to equity swaps may now be conducted against the will of the existing shareholders, subject to compliance with certain prerequisites. However, a conversion of debt to shares against the will of any one respective creditor remains invalid. Potential "change of control" termination provisions are blocked if the change of control occurs by way of a debt to equity swap provided for in an insolvency plan, but termination rights based on a breach of other contractual obligations are not affected. To further facilitate the use of insolvency plans, a voting group is deemed to have consented to the plan if the respective group is presumed to suffer no addition loss under the insolvency plan when compared to a liquidation scenario of the insolvent entity (i.e. out of the money creditors are not assessed on a going concern basis). This effectively provides a mechanism for the potential cram down of junior creditors. ESUG also seeks to diminish the delaying effects of court action against an approved plan by curbing creditors rights to object to, or appeal against, an insolvency plan. This is intended to prevent a creditor from blocking the insolvency plan and is supposed to tighten the proceedings to speed up the legally binding determination of the plan. Court driven approval proceedings shall ensure that a confirmed insolvency plan can be executed notwithstanding a pending appeal. III. SELF ADMINISTRATION ESUG sought to make self administration proceedings (Eigenverwaltung), also known as debtor inpossession proceedings, more readily available, as, whilst self administration proceedings had been introduced under the German Insolvency Code in 1999, they were not widely used due to the practical difficulties in obtaining the necessary court approvals. Under the new regime, the court must grant a debtor's application for self administration unless the 9

10 court is aware of circumstances that would mean that such an application would negatively affect the creditors' position. Where the creditors' committee supports the petition, there is a presumption that an order for self administration would not adversely affect creditors. The German legislator has also provided more flexibility in a restructuring situation by offering the possibility of a subsequent self administration proceeding upon application of the creditors' assembly, subject to debtor approval. Any influence of shareholders or existing controlling bodies on the management of the debtor company will be limited during the self administration period since the trustee/custodian, as well as the creditors' committee, are required to control the debtor's management on behalf of the creditors. These reforms should give the debtor extended control over the restructuring process, thereby encouraging the debtor to file relatively early for insolvency, increasing the chance of a successful business restructuring. IV. THE NEW PROTECTIVE SHIELD PROCEEDINGS ESUG established a new instrument of protective shield proceedings (Schutzschirmverfahren), a kind of pre insolvency proceeding which provides an automatic stay ahead of the appointment of an administrator. It was developed to provide the debtor, under the surveillance of a custodian, with a three month period in which to work out a restructuring plan. Protective shield proceedings will only be available if, at the time of the filing of the application for a protective shield, the debtor is not illiquid and the intended restructuring is not futile. This must be verified through the provision of a certificate from an accountant, auditor or insolvency lawyer at the time the application is made. Creditors have the right to apply for the repeal of the protective shield, therefore the debtor must communicate and work with its main creditors both before and after an application for a protective shield period. Furthermore, the court is able, on the application of the debtor, to order that preferential debt can be created during the protective shield proceeding, the aim being to ensure that the debtor's business can be continued as a going concern. This new instrument will act to protect both the interests of debtors and creditors at the critical time of distress before an insolvency appointment is made, and can be a useful tool in forcing obstructive minority creditors to restructure by virtue of an insolvency plan. In theory, this should allow for more successful implementations of pre packs. IMPACT ON THE LOAN MARKET The revised German insolvency regime seeks to provide more attractive and effective means to reorganise and rescue insolvent, or nearly insolvent, companies. The new statutory provisions provide an opportunity for debtor companies to reorganise in order to save the business, rather than simply liquidate it. The improvement of the creditors' influence on insolvency proceedings, together with the extension of the rights and measures that can be taken in insolvency proceedings, has significantly improved the position of creditors with respect to the assets of an insolvent company. This should open up 10

11 possible finance streams for German borrowers, with increased certainty and control for lenders making them more willing to finance the restructuring of a company. The option to elevate finance provided to a distressed company to preferential debt may also make lenders more willing to offer assistance to distressed companies, thereby increasing the likelihood of a successful restructuring. However, shareholders and junior creditors will need to be mindful of the cram down mechanisms and the potential implications on any claims in a subsequent insolvency, while senior creditors should benefit from these changes. Finally, it should be noted that German insolvency law applies on an entity by entity basis, i.e. there are no "group insolvency" proceedings in place. In addition, there are no genuine "pre insolvency proceedings" provided for within German insolvency law, i.e. debtor companies still need to file for insolvency to benefit from the new procedures. Due to the stigma associated with such action, it is possible that German debtors will continue to look overseas and use procedures such as the English schemes of arrangement to effect a restructuring. 11

12 Section 4 ITALY Prior to 2005, the Italian bankruptcy system was centred on the idea that failed businesses should be liquidated and insolvent debtors expelled from the economic system. Strong disincentives, including criminal sanctions, to the granting of financing to distressed businesses were in place and as a result, pre insolvency restructurings were kept out of court and, therefore, outside of a clear framework of legal protection. In an effort to address this, the "Italian Bankruptcy Law" 15 underwent substantial reform aimed at resolving corporate distress and facilitating the turnaround of companies, with a view to preserving the value of the business, thereby allowing it to make a fresh start. The 2005, 2006, 2007 and 2009 reforms 16 introduced pre bankruptcy schemes of arrangement 17 and a more efficient regulation of the pre bankruptcy agreement procedure 18. However, after the worsening of the financial crisis it became apparent that the restructuring framework was in need of further improvement. New rules 19 were introduced to further encourage the use of debt restructuring agreements and pre bankruptcy procedures, as explored in greater detail below. A. PRE BANKRUPTCY CREDITORS' COMPOSITIONS 20 (CONCORDATO PREVENTIVO) The concordato preventivo 21 has undergone significant reform aimed at increasing the efficiency of pre bankruptcy procedures by offering Italian companies in financial distress greater flexibility to overcome their difficulties while preserving business continuity. These reforms provide for: I. EARLY COMMENCEMENT OF THE CREDITORS' COMPOSITIONS Under the new reforms, debtors can apply to court to commence the creditors' composition procedure before the plan itself has been fully formulated. This innovation provides the debtor with the benefit of a stay on enforcement and protective actions upon the filing of a petition for concordato preventivo and its registration in the Register of Companies, allowing the debtor "breathing space" to formulate the composition plan. This is intended to help improve the chances of a successful restructuring. 15 Royal Decree No. 267 of 16 March The Italian Bankruptcy Law was amended by Legislative Decree Law No. 35 of 14 March 2005, ratified by Law No. 80 of 14 May 2005; Decree No. 5 of 9 January 2006; Legislative Decree No. 169 of 12 September 2007; Law No. 2 of 28 January 2009 and Law No. 69 of 18 June Article 67, paragraph 3, letter d) of the Italian Bankruptcy Law: the out of court debt restructuring plan (piano attestato di ris anamento); and Article 182 bis of the Italian Bankruptcy Law: the debt restructuring agreement (accordo di ristrutturazione dei debiti). 18 Articles 160 et seqq. of the Italian Bankruptcy Law. 19 Decree Law No. 78 of 31 May 2010 as amended and ratified by Law No. 122 of 30 July 2010 and Decree Law No. 83 of 22 June 2012 as amended and ratified by Law No. 134 of 7 August 2012 (the "Decree"). 20 Article 160 et seqq. of the Italian Bankruptcy Law. 21 Under the concordato preventivo a distressed debtor may propose to its creditors a plan of reorganisation that can achieve the restructuring of the business by any means, including debt restructuring, debt assumption, merger transactions, debt for equity swaps and/or the different treatment of varying classes of creditors, provided that such plan is, among other things: (i) certified as to its feasibility by an independent third party expert; (ii) approved by creditors representing the majority of the claims admitted to vote (i.e. 50% + 1) and, in cases where the creditors have been divided into different classes, approved by creditors representing the majority of claims admitted to vote in the majority of classes; and (iii) ratified by the bankruptcy court. The court may cram down dissenting creditors if the plan is approved by the required majorities and the court finds that dissenting creditors will receive under the plan at least as much as they would potentially receive under any available alternatives, i.e. the liquidation of the business. However, the court cannot prevent dissenting creditors from proposing competing plans for the purpose of showing the court that they would recover a greater amount under available alternatives. 12

13 In order to benefit from this process, the debtor must file, together with the petition, its financial statements for the preceding three years, enabling the court to ascertain: (1) whether the business meets the pre requisites for insolvency under Italian Bankruptcy Law; (2) whether the court has geographic jurisdiction; and (3) whether the petitioner has the authority to submit a composition petition. A pre composition petition will not be admissible if a similar petition has been filed in the preceding 2 years. Further, in order to avoid misuse of this process, some Italian courts, including the Court of Reggio Emilia and the Court of Milan, have issued guidelines to clarify their approach to any petition under Article 161 of the Italian Bankruptcy Law. Where the concordato preventivo is granted, the court will allow the debtor between days for the drafting of the plan and the filing of any further necessary documents. The court may extend this period by up to 60 additional days where justified. Alternatively, and within the same term, the debtor may file an Article 182 bis restructuring agreement, together with the required documents. This new rule provides for much quicker access to bankruptcy protections and maximises the debtor s leverage vis à vis its creditors. This new rule should provide for an early emergence of the debtor s crisis, as the debtor will not have to fear the commencement of creditor actions, increasing the chances of the successful restructuring of businesses. However, these reforms may be less welcomed by creditors, who could find themselves having to deal with an automatic stay imposed even where a plan has not been drafted. II. CHERRY PICKING CONTRACTS The reforms permit a debtor (with court approval) to withdraw from, or suspend its obligations under, certain existing contracts, irrespective of the terms of the contract, if this would facilitate the restructuring. 22 Alternatively, the debtor may ask the court to suspend its duty to perform under such contracts for 60 days (extendable by up to 60 additional days for justified reasons) in order to have enough time to decide whether to assume or to reject such contracts. In the event the contract is terminated, the other contractual party will be entitled to an indemnification equal to the damages arising from the failure to perform the agreement. This claim will be treated as receivables that had arisen before the concordato preventivo petition was filed. III. PRESERVATION OF BUSINESS CONTINUITY A new provision was introduced, aimed at allowing the continuation of business. Previously, where a petition for a concordato preventivo was filed, a period of uncertainty ensued between the filing of the petition and the issuance of the court's decree allowing (or rejecting) the concordato preventivo. Such period often had the negative effect of paralysing the operations of the company. The new provision provides that, as of the date of the filing of the application with the Register of Companies, the debtor is (1) authorised to perform acts of ordinary administration; and (2) entitled to request the court's approval for any act of extraordinary administration. In addition, the debtor may ask the court to approve specific payments for goods and services due before the filing, provided that an independent third party expert certifies that the goods and services rendered by such vendors and suppliers are (1) essential to ensure the continuity of the business; and (2) instrumental to enhance the recovery of all creditors. 22 Article 169 bis of the Italian Bankruptcy Law. This provision on pending contracts is not applicable to (i) dispute resolution clauses; (ii) employment contracts; (iii) lease agreements under Article 80 of the Italian Bankruptcy Law; and (iv) preliminary agreements under Article 72(VIII) of the Italian Bankruptcy Law for the sale of real estate for residential purposes. 13

14 Where a debtor commences a concordato preventivo aimed at preserving its business continuity ("concordato preventivo con continuità aziendale") 23 : 1) creditors cannot terminate executory contracts on the basis of the debtor s insolvency, despite any provision in the contract to the contrary; 2) pending contracts cannot be terminated, including those contracts entered into with a public authority; 3) a debtor will be able to participate in competitive public contract tenders; and 4) a debtor can present joint offers with other entities in connection with public contract tenders, provided specified independent third party expert evidence is submitted to court. In addition, should the concordato preventivo proposal provide for the sale of the business as a going concern, the reform provides that the business may be sold free from encumbrances. IV. FINANCINGS OBTAINED DURING A CONCORDATO PREVENTIVO A debtor who files a request for a concordato preventivo may request that the competent court authorises the debtor to enter into loan agreements whose proceeds shall be considered as supersenior. In order to qualify, an independent expert must certify that such loan agreements will better enable the debtor to carry on its business and satisfy its creditors in the long term. The court may also authorise the debtor to grant mortgages and pledges as security for such loans. In addition, a new amendment addressing the risk of clawback proceedings has been introduced, which relates to acts associated with interim funding obtained during a concordato preventivo. This offers lenders and/or investors providing interim funding arrangements protection from clawback from the filing date of the composition petition rather than from the date of the sanctioning by the court. These reforms should increase the financing available to distressed companies, which typically face cash shortfalls when seeking to finalise their restructuring plans, thereby increasing the likelihood of a successful reorganisation. B. DEEMED CONSENT TO A COMPOSITION Creditors who have not exercised their voting rights can dissent in writing to the composition proposal within 20 days from the date of adjournment of the meeting of the creditors. Failing any such dissent, these creditors will be deemed to have consented and will be calculated as having voted for the approval of the composition. 24 This will allow the plan to be approved and go ahead in the event that creditors are not interested in voting and represents a material change in the process of approving the composition with creditors. 23 Pursuant to Article 33, paragraph 1, letter h) of the Decree, a concordato preventivo con continuità aziendale encompasses plans of reorganisation providing for: (a) the continuation of the business by the debtor; or (b) the sale of the business as a going concern; or (c) the contribution in kind of the business as a going concern to one or more entities (including new entities). A concordato preventivo con continuità aziendale is governed by special rules where, among other things: (1) an independent third party expert must certify that preserving the business continuity is instrumental to enhance the creditors recovery; and (2) the plan of reorganisation must contain an analytic description of the expected proceeds and costs and of the financial resources necessary to fund the business continuity. 24 Article 178 of the Italian Bankruptcy Law. 14

15 C. PRIORITY FOR RESTRUCTURING FINANCE The new Article 182 quater provides that new financing, made available (1) in the implementation of pre bankruptcy agreements or Article 182 bis debt restructuring agreements 25 (which have been approved by the court (omologazione)); (2) in a composition with creditors; or (3) for the purposes of filing a petition, will be treated as a statutory expense of the procedure, i.e. as super senior, in any subsequent insolvency proceedings. Such financing must be provided by banks or certain financial institutions enrolled with the Bank of Italy under Articles 106 and 107 of the Italian 1993 Banking Act 26, and must meet the conditions set out in Article 182 quater. Prior to the amendment, claims for "new money" extended to distressed companies were deemed unsecured in an insolvency scenario, unless secured by a mortgage, pledge or lien. Similarly, bridge financing provided for by shareholders is considered super senior and is payable in priority of 80% of the amount in any subsequent insolvency proceedings. Loans granted by persons who become shareholders as a result of the restructuring plan are also payable in full. D. SUPER PRIORITY FOR NEW MONIES Legislation imposing criminal sanctions for bankruptcy 27 does not apply to new funds borrowed by the distressed debtor after the filing of a petition or the filing of the plan for composition (or precomposition) or a debt restructuring agreement 28. Previously, legislation only provided for the nonapplication of these provisions to payments and other transactions carried out in the context of compositions or restructuring agreements. This exemption will not apply where the restructuring procedure fails and the competent court determines that the restructuring procedure was not reasonable when originally implemented. In addition, the exemption does not extend to payments or transactions carried out prior to the implementation of the selected restructuring procedure or in the negotiations of a restructuring plan that is not ultimately validated by a competent expert or the court. In addition, it should be noted that a new offence of "false attestations and reports" applies to any professional who, in preparing the attestations and reports required under Bankruptcy Law, includes false information or omits material information. These amendments should encourage the use of the pre bankruptcy and debt restructuring arrangements in place, by creating a less risky legal environment for debtors, shareholders, lenders and new equity or debt investors should the restructuring fail and the debtor be subsequently declared bankrupt. 25 Restructuring agreements pursuant to Article 182 bis of the Italian Bankruptcy Law are pre packaged reorganisation plans that can achieve the debtor s restructuring by any means provided that (1) an independent third party expert certifies the feasibility of the plan; (2) creditors holding at least 60% of the total debts approve the plan; and (3) the competent bankruptcy court ratifies the plan. Dissenting creditors must be paid in full and cannot be subject to cram down. The debtor must seek court ratification of the agreement and publish the agreement on the Register of Companies (following which, for 60 days, creditors actions on the debtor's assets are stayed). In addition, a new paragraph has been introduced to Article 182 bis under which a debtor may request the court grants a moratorium during the negotiations of a debt restructuring arrangement. 26 Legislative decree No. 385 of 1 September Article 216(3) (bancarotta fraudolenta preferenziale) of the Italian Bankruptcy Law: the making of payments or granting of security, prior to or during the bankruptcy procedure, for the purpose of preferring certain creditors to the detriment of other creditors; and Article 217 (bancarotta semplice) of the Italian Bankruptcy Law: causing a delay to the declaration of bankruptcy as well as, amongst other things, being involved in highly risky transactions which caused a significant reduction of the net asset value of the company or aggravated the financial distress of the company by failing to make the required filings for bankruptcy or by adopting any other grossly negligent conduct. 28 Article 217 bis of the Italian Bankruptcy Law. 15

16 IMPACT ON THE LOAN MARKET These reforms provide lenders and investors in distressed companies with a clear and safe legal framework within which to operate. This should increase the level of liquidity available to distressed companies and should facilitate restructuring deals. The new provisions on the super seniority of certain claims represent a significant change in the legal framework of Italian insolvency law and may incentivise investors to participate in the recovery efforts of distressed companies, which should aid the development of the rescue financing market which is scarcely developed in Italy. Furthermore, the granting of super seniority provides an opportunity for shareholders to inject cash with an investment risk similar to that of a debt provider, as opposed to the higher risk faced by an equity provider. It remains to be seen whether banks will allow shareholders to inject debt rather than additional equity when negotiating a restructuring agreement. 16

17 Section 5 SPAIN Distressed companies in Spain have tended to shy away from formal insolvency mechanisms, instead leaving them to the last minute when it is usually too late. The Spanish Insolvency Act 29 ("SIA") came into force in 2004, aimed solely at modernising the treatment of insolvency in Spain. In addition, a new type of court the Commercial Court was created, tasked first and foremost with conducting insolvency proceedings. Despite the protections afforded under the new legislation, the number of insolvency proceedings in Spain remained substantially below the European average, with companies choosing to avoid formal insolvency mechanisms. However, from the start of the financial downturn in 2007, the number of insolvencies dramatically increased, with the majority ending in liquidation rather than a successful restructuring of the business. Legislators therefore undertook a review of SIA in light of the gravity and characteristics of the downturn. The result of this was the Insolvency Law Report 30 (the "2011 Reform"), which came into force on 1 January The 2011 Reform s preamble sets out that it seeks to foster alternatives to formal insolvency proceedings, giving companies more economical and flexible alternatives through refinancing agreements. It signalled a clear shift by legislators towards pre insolvency mechanisms and the preservation of business. Additionally, the 2011 Reform introduced important modifications to SIA, aimed at streamlining insolvency proceedings, simplifying some aspects of the same and providing more flexibility to the sale of assets of the estate within insolvency proceedings. This section will look at the key provisions in the 2011 Reform which helped reformulate the preinsolvency procedures available to companies rather than those modifications which sought to streamline insolvency proceedings. A. DUTY TO INITIATE INSOLVENCY PROCEEDINGS SUSPENDED Like many civil law jurisdictions, Spain imposes a specific time limit on distressed debtors to initiate formal insolvency proceedings when it becomes apparent that they are insolvent. This often led to management seeking the protection of the court to avoid incurring personal liability as opposed to exploring possible restructuring opportunities available to the business. Prior to the 2011 Reform, a debtor had to file for insolvency within 2 months of being in a state of insolvency. However, a new Article 5 bis of SIA (repealing Article 5.3 of SIA) was introduced, which allows debtors to "stop the clock" and utilise a four month moratorium to agree a proposal for a restructuring agreement (propuesta anticipada de convenio) or an out of court refinancing agreement (acuerdo de refinanciación formal 31 or "Formal Refinancing Agreement") with its creditors. In order to benefit from this moratorium, the debtor must present a notification in the prescribed 29 Law 22/ Law 38/2011 of 10 October Article 71.6 of SIA. 17

18 form addressed to the court authorised to hear its proceedings. The debtor is not obliged to submit any evidence in respect of the restructuring negotiations and the court is not obliged to carry out any verifications. During the four month period, any request for compulsory insolvency proceedings filed by a third party will not be admitted by the court. B. FORMAL REFINANCING AGREEMENTS I. PROTECTION FROM CLAWBACK RISK The 2011 Reform introduced a protective shield against clawback actions offered to parties to a refinancing agreement. Where insolvency (concurso) is declared, a refinancing (and any transactions, acts, payments and security entered into or carried out in connection with that refinancing) will not be subject to the two year clawback period provided certain conditions can be met. These include (1) approval by creditors representing at least 60% of the debtor's liabilities (both secured and unsecured); (2) the approval from an independent expert appointed by the commercial registry corresponding to the place of the debtor's registered office; and (3) the requirement that the refinancing agreement be formalised in a public deed. Receivers are still entitled to challenge the refinancing agreements if they consider such agreements to be prejudicial to the estate of the debtor. II. NEW MONEY The 2011 Reform introduces a debtor in possession financing, or "fresh money", concept whereby fresh money provided to the debtor in the context of a refinancing is prioritised in any subsequent liquidation proceedings. New funds made available to the debtor before the insolvency proceeding, i.e. under a Formal Refinancing Agreement, are enhanced so that 50% of the fresh money granted will be considered "super senior" (contra la masa) 32 in an insolvency 33. The remaining 50% will be considered to rank as "generally privileged" (privilegio general) 34. Where, subsequent to a company entering a formal insolvency process, fresh money is provided to finance a viability plan, 100% of this fresh money granted is to rank "super senior" in an insolvency. Similarly, although not a conventional financing method, the 2011 Reform paves the way for the buying and selling of pre petition claims (and, therefore, for professional trading in liabilities and for the associated loan to own strategies) by removing the voting ban that these sales previously entailed 35, provided that the buyer is an "entity subject to financial supervision", i.e. it is not connected to the debtor. It should be noted that new financing cannot be provided by the debtor (or by a person with a specific connection to the debtor (persona especialmente relacionada)) in the form of capital 32 "Super senior" claims are classified as being a post declaration credit and will rank prior to generally privileged, ordinary and subordinated claims, but will not supersede the securities of creditors over specific assets. 33 New wording introduced under Article of SIA. 34 "Generally privileged" claims will rank ahead of unsecured and subordinated creditors but behind (1) secured creditors to the extent of the proceeds from the secured assets; and (2) creditors whose claims are classified as being against the estate (contra la masa). 35 Amended Article 122 of SIA. 18

19 increases, loans or similar transactions. III. CRAM DOWN OF DISSENTING CREDITORS Prior to the 2011 Reform, there was no means by which the majority of creditors could bind dissenting creditors under a refinancing agreement. This led to a number of Spanish restructurings being implemented in more creditor friendly venues, for example La Seda de Barcelona 36 and Metrovacesa 37 both applied to the English courts for a scheme of arrangement (both companies relying on the fact that they had submitted to the law and courts of England in their syndicated facility agreements), through which they were able to successfully cram down dissenting creditors and restructure their banking liabilities. The 2011 Reform allows the extension of the debt rescheduling terms of a Formal Refinancing Agreement on dissenting creditors provided it (1) has the support of at least 75% of creditors who are owed financial liabilities; (2) receives a favourable report from an independent expert; and (3) the dissenting creditors do not hold in rem security (garantía real). Court approval is likely to be obtained where the requisite conditions are met, unless the Formal Refinancing Agreement imposes a "disproportionate sacrifice" 38 on the dissenting creditors. Once approved, the agreement imposes a moratorium on claims, applicable to all unsecured creditors for up to 3 years. However, absent any specific prohibitions, secured creditors may still be able to take enforcement action. In the event of a breach of the Formal Refinancing Agreement by the debtor, creditors can request a judicial declaration of breach from the relevant court that would allow them to initiate insolvency proceedings or the enforcement of security over assets. IMPACT ON THE LOAN MARKET As noted above, the 2011 Reform seeks to promote the restructuring of distressed companies in a number of ways. It has opened the way for loan market participants to engage in the restructuring of distressed companies by offering protections from clawback actions and the prioritisation of their claims in any subsequent liquidation. Whilst SIA does not yet provide for an absolute priority for fresh money, the reforms in place should encourage lenders to provide financing to a greater number of restructurings, thereby increasing liquidity in the restructuring market. Going forward, it would be desirable to extend the out of court refinancing to loans secured by mortgages and pledges. In the event of a subsequent insolvency, the existence of new super senior claims is likely to have a detrimental impact on any unsecured creditors, therefore, junior lenders are likely to require security when becoming party to a loan transaction. The extent to which Spanish companies will utilise the new procedures available to them under the 2011 Reform over foreign alternatives, such as the English scheme of arrangement, remains to be seen. For the time being the utilisation of the 2011 Reform has been practically restricted to the 36 [2010] EWHC 1364 (Ch). 37 [2011] EWHC 1014 (Ch). 38 "Disproportionate sacrifice" is not defined and will be interpreted at the courts' discretion. 19

20 protection of refinancing agreements from clawback risks, and more frequently, the communication foreseen in Article 5 bis of the Insolvency Law in order to benefit from the moratorium therein. 20